Firing Tax and Severance Payment in Search Economies: A Comparison

39 Pages Posted: 25 Apr 2003

See all articles by Pietro Garibaldi

Pietro Garibaldi

Bocconi University - Department of Economics; Centre for Economic Policy Research (CEPR); IZA Institute of Labor Economics

Giovanni L. Violante

New York University, Department of Economics; Centre for Economic Policy Research (CEPR)

Date Written: November 2002

Abstract

Employment Protection rules have two separate dimensions: a transfer from the firm to the worker to be laid off and a tax paid outside the firm-worker pair. It is well established that with full wage flexibility statutory severance payments (pure transfers) between employers and dismissed employees are neutral (Lazear 1988, 1990). Most of the existing literature makes the implicit assumption that, in the presence of wage rigidity, such mandatory transfers have the same real effects as firing taxes. This Paper shows, in the context of a search model, that this presumption is in general misplaced. It is only correct in the case of extreme wage rigidity, whereas when some (but not full) flexibility in the wage setting at the level of an individual employer-worker match is allowed, the impact of severance payments on unemployment duration and incidence is qualitatively different from that of firing taxes (and its sign depends on the nature of the wage rigidity).

Keywords: Firing tax, severance payment, wage rigidity, unemployment

JEL Classification: E24, J64, J65

Suggested Citation

Garibaldi, Pietro and Violante, Giovanni L., Firing Tax and Severance Payment in Search Economies: A Comparison (November 2002). CEPR Discussion Paper No. 3636. Available at SSRN: https://ssrn.com/abstract=361043

Pietro Garibaldi

Bocconi University - Department of Economics ( email )

Via Gobbi 5
Milan, 20136
Italy
+39 02 5836 5422 (Phone)
+39 02 5836 5343 (Fax)

HOME PAGE: http://www.frdb.org/~pietrogaribaldi/

Centre for Economic Policy Research (CEPR)

London
United Kingdom

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

Giovanni L. Violante (Contact Author)

New York University, Department of Economics ( email )

269 Mercer Street
New York, NY 10003
United States
212-992-9771 (Phone)
212-995-4186 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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